Opportunities in Machinery Stocks

An outlook and overview of the global machinery industry from an investor's perspective

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A world economic recovery, as seen from equity market improvements off the lows experienced since the 2008 global crisis, has been quite impressive. The journey was difficult with ever-present headwinds hindering growth, the most recent of which was the eurozone debt crisis that slowed down the overall growth pace significantly in 2011. Lingering effects also impacted the first quarter of 2012; however, the global economy has eventually reverted to the recovery path, though obstacles still persist.

According to the World Economic Outlook published by the International Monetary Fund, or IMF, in April 2012, the world economy is expected to grow roughly 3.5% in 2012 and 4.1% in 2013. Growth in advanced economies is projected at 1.4% in 2012 and 2.0% in 2013, while it is anticipated that the emerging and developing countries would grow by 5.7% in 2012 and 6.0% in 2013.

No doubt there exist some renewed concerns about the global growth outlook following the recent run of weak reports from the US and India, but the overall growth picture may not materially deteriorate from the IMF's April forecast.

Demand for the Machinery industry is correlated with increasing economic activity, which stimulates demand for industrial products and hence increases the need for new/advanced machinery. The major end-markets for the machinery industry includes agriculture, construction, mining and energy industries, among others.

Machinery Prospects Bright in the United States

The IMF projects the United States to grow 2.1% and 2.4% in 2012 and 2013, respectively. Increasing consumption, higher exports and improved employment conditions despite recent evidence of softness all bode well for the economy. Gross fixed capital formation is projected to grow 4.8% and 5.9% in 2012 and 2013, respectively.

The Machinery industry is one of the most attractive industries in the United States. Growth prospects for this industry, as can be deduced from the indicators to the performances in the recent past, look promising. In the first quarter 2012, industrial production in the United States rose by 5.4% while manufacturing output increased by 10.4%. The US Census Bureau report indicates a 13.1% year-over-year rise in machinery shipments and a 10.4% increase in new orders. Machinery order backlogs at the end of the quarter have escalated 22.7%.

End-market demand remains strong. In the first quarter, new orders for construction and industrial machinery rose by 17.8% and 14.5%, respectively. Orders for mining equipment were, however, down 17.5%. Farm machinery shipments rose 24%. Spending on construction equipment increased in the quarter, including a rise in residential and non-residential spending.

Japan's Cabinet Office reported a 0.9% increase in core machine orders in the first quarter of 2012 as compared with the previous quarter and a 3.3% rise from the year-ago quarter. Increasing consumer spending and higher reconstruction activities have accelerated recovery in the country. The government has projected 2.5% machine order growth for the second quarter of 2012.

Also, according to the IMF, the Japanese economy is projected to grow 2.0% in 2012 and 1.7% in 2013.

Emerging Nations - Set for Growth

China and India, the two major emerging/developing nations, are expected to show signs of tangible growth in the years to come. According to the IMF, the Chinese economy is projected to grow 8.2% and 8.8% in 2012 and 2013, respectively.

Looser fiscal and monetary measures by the Chinese authorities, along the lines of Thursday's interest rate cut by the Chinese central bank, are expected to offset some of the recent weakness in economic data. Fixed Asset Investment has been on the rise over the years, with a major share being invested in the machinery industry. The country's domestic demand and investments will help in offsetting lower export demand from its biggest export region, the European Union.

Industrial production in India has been weak in recent months, and the first quarter GDP report was the weakest in years. However, the country is projected by the IMF to grow 6.9% in 2012 and 7.3% in 2013. Demand for agricultural equipment is expected to rise in an effort to modernize the existing farming techniques.

Korea's industrial output in the first quarter 2012 gained 3.7% year over year; machinery investments increased 11.4%. However, construction activities were weak in the quarter. The IMF predicts the economy will grow 3.5% in 2012 and 4.0% in 2013.

Thailand seems to be recovering fast from the ravages of its floods; reconstruction activities are perceptible in the region to spur demand in the machinery industry.

Other Major Players

As per data released by the Brazilian government, economic growth in Brazil remains healthy; projected to grow from 2.7% in 2011 to about 3.5% in 2012. Upcoming sporting events to be held in Brazil, rising government spending to improve the country's infrastructure, growing trade relations with other economies, as well as huge foreign direct investments all bode well for the economy.

South Africa is also making progress; expected to grow 2.7% in 2012 and 3.4% in 2013, as projected by the IMF. The government is focused on improving its mining, manufacturing and agricultural sectors. Moreover, huge public investments in the infrastructure development programs remain in the forefront.

Eurozone -- A Hurdle

The eurozone debt crisis has slowed down the overall growth pace in the region. According to a report published by Eurostat in May 2012, industrial production (excluding construction) in the eurozone fell 2.2% year over year in March 2012 and declined 0.3% compared with February 2012. The capital goods formation growth rate fell from 1.4% in February 2012 to 1.1% in March.

On a monthly basis comparison, industrial production in Spain fell by 1.8% in March 2012, France -0.9%, Estonia -3.4%, Luxembourg -1.9%, Denmark -2.8%, the Netherlands -9.0% and Ireland -2.7%. However, industrial production in Germany and Italy grew by 1.3% and 0.5%, respectively.

However, Construction output increased 12.4% in March 2012 compared with the previous month, with the largest increase recorded in Germany (30.7%). Output in France rose by 17.8%, Italy by 9.5%, and in the United Kingdom by 14.8%.

Also, according to the VDMA machine makers association, German machine tool orders in the first quarter 2012 plummeted 7%, with domestic orders down by 1% and international orders sliding by 9%.

Italy-based CNH Global NV (CNH) posted a 22% increase in its equipment sales (agricultural and construction) in the first quarter 2012. Worldwide agricultural equipment retail demand in 2012 is expected to be flat to up 5% and construction unit demand up 5% to 10%.

Other top players in the agricultural, construction and mining industry includes: AGCO Corporation (AGCO), The Toro Company (TTC), Terex Corp. (TEX), and Kubota Corporation (KUB), among others.

Fiscal government expenditures play a counter-cyclical role curbing the ill effects of slower economic developments and a tight credit market. Recently, China has come forward with its structural stimulus package for 2012. Government spending on social welfare, construction of low-cost housing, completion of infrastructure projects on agriculture, forestry and water resources received special attention.

Also, the US Congress had a stimulus package designed in 2009 that had money flowing into infrastructure spending. Also, The American Energy & Infrastructure Jobs Act (H.R. 7), when approved, will boost spending in the infrastructure projects. Approximately $260 billion will be allocated to fund roads, bridges and highway projects over five years.

Another major event for the global economy is Russia, joining as a World Trade Organization (or WTO) member in 2012. The membership will open the gates for companies worldwide to benefit from the growing needs of modernizing the agricultural, transport and infrastructure sectors of the economy.

WEAKNESSES

We remain wary of the rising raw material costs of some of the major players of the machinery industry. Steel prices along with energy, especially coal and fuel prices remain the prime causes of concern.

Research and development costs are on the rise for machine makers in their pursuit of manufacturing more sophisticated and technologically advanced machinery. Availability of funds remain difficult as some major nations are still struggling to bring stability to their own economies.

Favorable commodity prices are a boon, although government policies affecting prices along with export and import policies and trade relations with other countries impact the machinery industry.

Conclusion: Prospects Bright

Rising needs of better infrastructure, modernized methods of agriculture and growing complexity of mining/manufacturing methods will boost demand for technologically advanced equipment in those industries. Moreover, looking ahead on the growth path, emerging and developing nations will inevitably be an attractive destination for machine makers worldwide.

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